Solar Financing – Part 2: Programs and Incentives

This second post in our series on financing renewable projects will build on Post 1 to provide an introduction to the available programs and incentives that make solar & storage investments particularly attractive. Government programs and incentives have historically fostered technological innovation by increasing it’s financial viability [ brief | dive ]. While there is undeniable value in the services provided by distributed generation, like peak shaving, demand management, and demand response, the market has not yet quantified the value in potential revenue streams. Therefore, what often makes a project viable are the available government programs and incentives. Unfortunately, the interrelations between the numerous federal and state incentives are difficult to navigate. On top of that, they can vary greatly from state to state, making it hard to determine what path is best for a project. To simplify things, in this post we will review only four of the largest and most widely used renewable programs and incentives: Net Energy Metering, Feed In Tariffs, Investment Tax Credits, and Bonus Depreciation & MACRS.

Programs

The following programs are meant to encourage faster adoption of renewable energy resources but are not necessarily meant to be scaled in the long run. Thus in general, these incentives will ramp down over time to prevent overburdening of the grid and oversaturation of the market.

Net Energy Metering (NEM): NEM is a program that allows on-site generated energy to offset the site’s energy consumption. However, unlike a standard non-export, behind the meter generating facility (GF), under NEM, all excess on-site generation can be exported to the grid in exchange for credit equal to the cost of purchasing that same energy. Unused credit at the end of a monthly billing cycle is carried over to the next billing cycle instead of being lost. There is also an option to participate in Net Surplus Compensation (NSC), a program that allows net GF’s (GF’s that produce more energy than they use) to be compensated for their overproduction on a yearly cycle at wholesale prices. Under NEM the grid basically becomes a battery of unlimited capacity, minus the ability to conduct demand management and other cost saving functions which would require control. This is incredibly valuable for desired generators as the risk of overproduction is greatly reduced. NEM programs often have a system size cap (usually as a capacity or % of load), which creates a threshold to how many credits could be generated, but it is much more appealing than the alternative of losing any excess generation.

NEM in CA: California has been a pioneer of the NEM program and the clear leader in installed NEM capacity (over 2 GW installed to date). In July 2017 CA shifted from NEM-1.0 to NEM-2.0 (which will last until 2019). This marks the first stage of its transition from the original program and adds a few important updates: (1) All customers installing a solar system will be automatically switched to Time-of-Use (TOU) rates. This means that the value of the exported excess energy depends on the time during which it was exported (i.e. energy exported during an on-peak period will be worth more than energy exported during an off-peak period), making the option of choosing when to export energy through a combination of solar + storage even more appealing; (2) there is an additional interconnection fee required depending on your utility; (3) NEM facilities are no longer fully exempt from Non-Bypassable Charges (NBCs) (under NEM-2.0, all energy delivered by the grid will be subject to NBCs of ~0.02 – 0.03 $/W).

Feed-in Tariff (FiT): A FiT is similar to NEM in that it allows export to the grid. However, unlike NEM, exported energy is sold to the grid at a predetermined price, not stored as credit. This means there is no limit to how much energy one could export to the grid. Since rapid and large increases in exported energy can cause serious strain on the grid, many utilities have built in disincentives: (1) The base price is usually lower than the purchasing price of energy; (2) most states have either a project cap or program cap to limit the gross generation operating under the FiT program; (3) some include a “tariff degression” – a tiered decrease in selling prices based on how much or how long energy has been sold in the program.

Incentives

Similar to the programs above, these incentives are to create action NOW. Therefore they are limited in time and often contain degressive tiers.

Investment Tax Credit (ITC): The federal ITC permits purchasers of specific items (solar systems and battery systems are among those included) to take a tax credit equal to 30% of the investment. This is tiered down over time to 26% (2020); 22% (2021); 10% (2022+). Because solar developments can be fairly expensive, these 30% tax credits often correspond to large amounts of money in credits. Therefore, to take full advantage of the ITC, the developer must either have a large enough tax appetite (which is uncommon), or they must enter a third party financing agreement with a tax equity.

Bonus Depreciation & MACRS:Bonus Depreciation and MACRS (Modified Accelerated Cost Recovery System) are federal incentives designed to encourage and accelerate investment in private development. Each incentive reduces the timeline of depreciating an asset, reducing tax liability and increasing rate of return on an investment. Note: Projects utilizing the Federal ITC must reduce the depreciable value by half of the ITC credit (if 30% ITC is claimed, a 15% reduction or 85% total depreciable value).

Bonus Depreciation: As a response to the 2008 recession, Congress passed an Act allowing companies to depreciate a larger portion of their investment in its first year. It started as 100% bonus depreciation for capital investments put in place by December 31, 2011, but has since been extended multiple times to its most recent iteration – a tiered degression. The tiers are as follows: 50% bonus (2015-2017); 40% (2018); 30% (2019); 0% (2020+).

MACRS: Similar to Bonus Depreciation, MACRS are a method to accelerate the depreciation process. However, instead of a single year increase, MACRS allow an investment to be depreciated over a set shortened timeline. For solar, this is a 5 year recovery period, but the timeline varies depending on the technology being depreciated. The exact yearly depreciation varies (usually weighted more heavily towards the early years), but a 5 year recovery period averages to 20% a year.

These particular incentives are not mutually exclusive; a single project could use any number of the above incentives in parallel. To see how they affect each other, here is an example case:

In total, the first year tax deductions are equal to $454,700 ($300,000 from ITC and $154,700 from depreciations). This equates to a ~45% savings on your investment within the first tax year!

As you can see, these incentives lead to massive savings, showing why they can be so influential in encouraging investment. While the total amount of savings is the same regardless of the depreciation route you take, the depreciation incentives above provide the cash in hand at a much earlier date (full depreciation in ~5 years rather than ~35 years). Earlier return means quicker access to capital and in turn a quicker return on investment. Combining the decreased cost of investment with the program benefits makes distributed generation a more valuable asset and a very attractive investment.